As telecommunication companies continue to look for alternative sources of financing, some of them have turned to the CMBS market, giving rise to a relatively new form of CMBS collateral: "telco hotel" properties - which are usually converted office, industrial and retail buildings that house "mission-critical voice, video, data networking, and transmission equipment."
"We have seen a fair amount of preliminary interest from lenders," said Peter Morral, an associate director from Standard & Poors. "And as more assets approach stabilization, I think that securitization is one route that owners looking to free up equity will explore."
Because of the increase in interest in this type of collateral, S&P issued a report recently on its rating criteria which considers gross potential rent, vacancy/credit allowance, operating expenses and tenant improvements and leasing commissions. In its report, the rating agency noted that these telecom properties are most similar to office properties. However, the agency approaches each asset on a case-by-case basis, considering the uniqueness of each situation.
"The major long-term concerns from a credit perspective currently include potential obsolescence and the absence of historic information covering areas such as sustainable rents and cap rates," said Morral. "There is really not a lot of history with this asset class although time should reveal what the risks are."
Fitch also recently included an article on the topic in its real estate update. The question it posts is whether telco hotels are a new property use or a new asset class, or both.
The report said that several factors would answer this question, including: the development, tenanting financing and sale cycle of telecom centers, the level of credit given to rent in place, potential alternative uses of the properties, as well as technological evolution.
And because of the novelty of the asset type, the rating agency remains cautious.
"Because of the newness of the property type no one really knows how it would perform over an economic cycle so we had to use conservative underwriting assumptions," said Gregg Delany, author of the Fitch article.
"If our surveillance people upgrade the ratings on these properties because they are outperforming our initial cash flow assumptions we will fine tune these parameters to reflect our increased knowledge of these assets."
CMBS deals with
telco hotel collateral
The first deal that included this type of collateral was the 85 Tenth Avenue Trust, which was underwritten by Lehman Brothers and rated by S&P.
According to an S&P pre-sale report, the property, which is secured by a fee mortgage on an 11-story building that is located at 85 Tenth Avenue in the Chelsea section of Manhattan, is also known as the Level 3 Gateway Facility. This property was originally constructed in 1914 and is now being converted into a telecommunications facility.
The securities were eventually sold in the private placement market.
One of the concerns raised by the rating agency in this deal is that it was being leased to a single tenant, Level 3 Communications LLC, a subsidiary of Level 3 Communications Inc. However, this risk is mitigated by the company's intent to lease a portion of the property.
Another deal that contained this type of property was the Fitch-rated J.P. Morgan/Deutsche Bank Alex. Brown's COMM 2001-JI, which had as part of its portfolio a telecommunications center located at 165 Halsey, Newark, NJ.
Lehman is rumored to be currently shopping four telecommunication centers owned by Exodus Communications to be included in a CMBS transaction. Exodus is a leading Web hosting company which services enterprises with mission-critical Internet operations. The firm provides system and network management solutions along with technology professional services.
Sources say that the arrangement would be similar to the Level 3 deal where Exodus would also be leasing the said properties. Lehman supposedly is taking advantage of the arbitrage between issuing junk bonds, which are unsecured, vs. this secured debt. Sources said that accessing the CMBS market would likely be a more efficient and cost-effective source of capital for the company.